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Editorial: Measures of Risk

Sure, hindsight is 20/20. But hopefully, as the industry starts to move past the blowup of the subprime sector, people on the origination side of the equation won't forget what got us into the trouble we are seeing today on the credit management side.

Fitch Ratings, which recently revised its analysis of single-family mortgage risk, has some data that remind the industry that to a large extent, we should have seen some of today's woes coming. According to Fitch, risk underwriting has deteriorated. The rating agency found that despite higher credit scores for both full-documentation and low-doc loans in 2006, the early performance of loans originated in 2006 and pooled into private-label mortgage-backed securities is considerably weaker than that for the vintage of loans originated in 2000.

What's to blame? Risk layering appears to be a culprit, according to the Fitch analysis. The confluence of higher-risk mortgage products with declining housing markets proved to be a toxic combination for many borrowers - and the lenders or investors who bore the credit risk on those loans. In addition, the rating agency said that mortgage fraud (mostly borrowers and real estate agents exaggerating income or other qualifications, and sometimes property values with the help of unscrupulous appraisers) for the sake of speculative property investment also played a large role. Fitch acknowledges that the shutdown of the mortgage origination and securitization markets for nonprime loans in mid-2007 has accelerated home price declines.

So far, Fitch believes that loan modification programs have been "slow to gain traction," but that doesn't mean they won't play an important role in the housing sector's recovery over the coming months and years. That's where servicers come into the equation. Along with investors and other stakeholders, servicers will ultimately determine how successful loan modifications will be. In the meantime, we hope the origination side of the business doesn't stray too far from traditional underwriting parameters in the future.

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